Tuesday, September 16, 2008


Rationalité limitée recommends this interview with Michel Aglietta on the current financial crisis but expresses doubts about Aglietta's call for new regulation to ensure that "institutional investors can correctly evaluate the risks" involved in the purchase of certain financial instruments. But "is this really possible?" asks the young economist who writes the blog. This question will be at the heart of political debate in coming months, so it will be important to get beyond the sterile confrontation of "regulation good" vs. "regulation bad." Indeed, there will be new regulation galore, whether good or bad, because the demand for it will become politically irresistible as the crisis widens and deepens.

Yet desire, when it grows strong enough, is endlessly resourceful, and capable of circumventing any and all regulation via recourse to the ruse of reason. Ulysses may have bound himself to the mast in order to resist the sirens' call, to which he knew in advance he would succumb, but though we may be aware of the problem, we never seem to make the bonds strong enough to contain us in our next bout of lust. Since our only defense against the tumescence of greed is appreciation of the potential for subsequent disaster, regulation should focus on heightening awareness of the risk of debacle and of the deceitful wiles of the concupiscence that wraps itself in the chaste disguises of "rationality."

The mad market for credit default swaps is a case in point. No one knows how large it is ($60 trillion, $100 trillion, $150 trillion--that's trillion, with a t), because there is no central repository of information. CDS's are supposed to provide insurance against credit defaults, but it seems that many of the insurers were glad to take the premiums even though they had far too little capital to make good on their promise to pay in case of default. No matter: default was assumed to be rare enough that it was still "rational" to make, and accept, a promise that both parties were (vaguely) aware could not be kept. One party could then assure its "regulators" (whether internal or external) that it was protected, while the other could earn an apparently cost-free supplement to its income. The Lehman bankruptcy and potential failure of AIG will soon reveal just how deluded the masters of the universe were.

In retrospect such arrangements seem irrational to the point of daftness; in prospect they seemed the quintessence of modern financial engineering with its mantra of "risk management." Regulation needs to step back from rationality, even the "bounded" rationality advocated by Rationalité limitée, to the more primitive stage of prudence, which stemmed from a healthy fear of the unknown that no one yet presumed to measure. The attempt to turn all uncertainty into quantifiable risk is the contemporary hubris responsible for the rebirth of tragedy.


kirkmc said...

These are all tough questions. On the one hand, we're dealing with the after-effects of greed; intense greed. While many of those who took out mortgages were working people who got hoodwinked (though you can argue that they should have understood what they were getting into), many were also people hoping to flip houses after a couple of months for a quick profit, both individuals and real estate agents.

As for the rest of the investment scam, that's all about greed and risk. There's no reason that risk should be prevented by the government (except in the case of bank accounts); people should take consequences for their greed. If it fails, that's too bad. On the other hand, when greed becomes systemic, it's a whole society that needs to be changed, and, perhaps, suffer to see the errors of their ways.

Note that I have only a small amount of money in the stock market; the rest is in bank accounts and similar investments. I've never bought into the whole deal. My mother, however, in the US, has money in both Lehman and AIG - not large sums, but for a retired person, any amount makes a difference. Both investments were qualified as "safe": one is an annuity, the other a bond. So she took very limited risk, getting a very small return, and is going to lose.


kirkmc said...

Just seen in an article on the Huffington Post:

In the long run, and ideally, this will sort itself out as the gamblers will be driven out of the business and Wall Street will be absorbed into heavily regulated commercial banking conglomerates.
This is as it should be. As financial guru James Grant, of Grant's Interest Rate Observer, said last year: "Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

That's kind of how I feel (does that make me a Republican?). So what if little people lose; they were in it for greed as well, hoping to get a better return but ignoring the risk.